KEY
Name: ______________________________ Section: __________ Row: ___________ Seat: __________
ECON 151-10 Spring 2007
Problem set #6
Pure Competition
Dr. Charlie Link
1. What are four characteristics of pure competition?
The four are: (1) the presence of a very large number of sellers that act independently in a market; (2) the
production and sale of a standardized or homogeneous product; (3) the individual firms are “price
takers” in the sense that the seller must accept the going market price for the sale of output; and
(4) new firms can easily enter the market and existing firms can easily exit the market.
4 points, one for each correct answer
2. Why does price equal marginal revenue for the purely competitive firm? (1 Point) What is the
relationship to the demand curve for the firm? (1 point)
The purely competitive firm is a “price-taker” in the market. The price it receives for its output is constant
and does not vary across its range of output. Marginal revenue is defined as the change in total
revenue from selling one more unit of output. One more unit of output will be sold at a constant,
market-determined price. Thus, price will be equal to the marginal revenue for the firm. Also,
the firm’s demand curve will be perfectly elastic because no matter how much or how little the
firm produces it will receive the same price per unit of output. Thus, demand equals price and
marginal revenue. (2 Points)
3. Below is a demand schedule facing an individual firm. Complete the table by calculating average
revenue, total revenue, and marginal revenue. Then answer the following two questions: (In the table
below there is 1 point for each correct column; average revenue, total revenue, and marginal
revenue – for a total of 3 points.)
(a) How can you tell whether a firm is operating in a market that is purely competitive? (1 Point)
The data indicate that the demand curve for this individual firm is perfectly elastic. Therefore, the firm is
operating in a purely competitive market because it can sell all of its output at the going market price of
$30. Product price is constant for the firm under pure competition.
(b) What relationship exists between average revenue and marginal revenue? (1 Point)
Marginal revenue and average revenue are the same under pure competition. Marginal revenue and
average revenue are also equal to price. Marginal revenue is constant under pure competition
because additional units can be sold at a constant price ($30). Because the seller must pay a
constant amount per unit ($30), the revenue per unit (or average revenue) is also equal to price.
[text: E pp. 401-402; MI pp. 167-168]
Quantity
Average
Total
Marginal
Price
demanded
revenue
revenue
revenue
$30
0
$ 0
$ 0
–––
30
1
30
30
30
30
2
30
60
30
30
3
30
90
30
30
4
30
120
30
30
5
30
150
30
30
6
30
180
30
1
4. Why is the level of output at which marginal revenue equals marginal cost the profit-maximizing
output? (3 Points)
The easiest way to explain this is to explain why it cannot be otherwise. If marginal revenue exceeds
marginal cost, then the firm can add to its profits by expanding production until marginal revenue
no longer exceeds marginal cost (either because the price declines eventually or diminishing
returns set in and marginal cost rises or both). If, on the other hand, marginal revenue is below
marginal cost, it would not be rational for the firm to expand production to this level. Why add
more to your costs than you add to your revenues since that means smaller profits?
If the firm would not produce when marginal revenue exceeds marginal cost, or when marginal
revenue is less than marginal cost, then it must maximize profits where marginal revenue equals
marginal cost.
5. You are given the following cost information. (1 Point for correctly filling in MC and 1 point for
filling in MR – total 2 points)
Output Total Cost
0
$2,500
1
2,700
2
3,100
3
3,700
4
4,500
5
6,000
MC
MR
200
400
600
800
1500
1200
1200
1200
1200
1200
(a) If the firm shuts down in the short run, the total costs will be: $2,500 (1 Point)
(b) If the product sells for $1,200 per unit, the firm’s profit maximizing output is: 4 units and earn
profits of $300. (1 Point)
Use the marginal revenue – marginal cost approach to obtain your answer. Show your numbers in
the table above.
6. Assume a single firm in a purely competitive industry has variable costs as indicated in the following
table in column 2. Complete the table and answer the questions. (1 point each for filling in each column
correctly for 5 points total)
(1)
Total
product
(3)
Total
cost
(4)
(5)
(6)
(7)
AFC
AVC
ATC
MC
0
$ 40
$_____
$_____
$_____
1
55
_____
_____
_____
_____
$_____
2
75
_____
_____
_____
_____
_____
3
90
_____
_____
_____
_____
_____
4
110
_____
_____
_____
_____
_____
5
135
_____
_____
_____
_____
_____
6
170
_____
_____
_____
_____
_____
7
220
_____
_____
_____
_____
_____
8
290
_____
_____
_____
_____
_____
0
(2)
Total
var. cost
$
2
(1)
Total
product
(2)
Total
var. cost
0
1
2
3
4
5
6
7
8
$
0
55
75
90
110
135
170
220
290
(3)
Total
cost
(4)
(5)
(6)
(7)
AFC
AVC
ATC
MC
$ 40
95
115
130
150
175
210
260
330
----$40.00
20.00
13.33
10.00
8.00
6.67
5.71
5.00
----$55.00
37.50
30.00
27.50
27.00
28.33
31.43
36.25
----$95.00
57.50
43.33
37.50
35.00
35.00
37.14
41.25
----$55.00
20.00
15.00
20.00
25.00
35.00
50.00
70.00
(a) The firm will produce 7 units ($52 covers MC of $50), at a profit of $14.86 per unit or total
profit of 7  $14.86 = $104.02. (1 point for the correct output and 1 point for the correct
profit figure)
(b) The firm will produce 5 units ($28 covers AVC of $27 and MC of $25) at a loss of $7 per unit
or 5  $7 = $35 total loss which is less than $40 fixed cost loss incurred by shutting down in the
short run. (1 point for the correct output and 1 point for the correct profit figure)
(c) The firm will shut down in the short run and absorb the fixed cost loss of $40. There is no
output level where $22 covers AVC.
(1 point for the correct output and 1 point for the
correct profit figure)
(d) See table below. . (1 point for the correct quantity supplied and 1 point for the correct
profit figure)
Product
price
Quantity
supplied
$72
52
45
28
22
15
8
7
6
5
0
0
Profit (+)
or loss (–)
+$246
+104
+60
–30
–40
–40
(e) $52 . (1 point)
(f) 7 units (1 point)
(g) plus $14.86 (1 point)
(h) plus $104.02 (1 point)
3